← InstitutionalLesson 3 · 3:54
Trading skew on its own: risk reversals
Summary
You can read the 25 delta risk reversal as the price of the skew, measure it across expiries and trade it with the direction hedged out. You can say what a hedged risk reversal earns or loses when the skew lifts, steepens or flattens, and why selling the put side is short the move that hurts most.
Key terms
- 25 delta risk reversal
- The implied volatility of the 25 delta put minus that of the 25 delta call in the same expiry, quoted as the price of the skew.
- wing
- An option away from the money on one side, such as the 25 delta put or the 25 delta call.
- skew
- The tilt of implied volatility across strikes, one volatility for each strike, usually rising toward the far puts.
- delta hedge
- Buying or selling shares so that small moves in the stock no longer change the value of the option position.
- steepen
- When the skew's tilt grows, so puts gain volatility compared with calls.
- flatten
- When the skew's tilt shrinks, so puts lose volatility compared with calls.
- 25 delta
- An option that moves about a quarter as much as the underlying price for a small move.
Check yourself
Answer each question to see why the right answer is right.
1. On the real December SPX line, the 25 delta put carries about 21% volatility and the 25 delta call about 14%. What is the 25 delta risk reversal?
2. Across every monthly SPX expiry from November to the next December, the risk reversal sat between about 6 and 7 points. What does that say?
3. You sell the XYZ $94 put, buy the $105 call and sell 52 shares. Why sell the 52 shares?
4. One day passes with XYZ unchanged. Your hedged trade (sold put, bought call) is held through three cases: every strike up 5 points, the skew steepening, and the skew flattening. Which result matches the lesson?
5. XYZ drops to $92 the day after you sell the put side, and fear lifts the put to 45% and the call to 32%. You are hedged. What happened, and why?
Finished the video and the quiz? .